Making sense of corporate moves
Companies take a number of steps to ensure that investors continue to find value in their stocks.
Share prices are greatly influenced by “corporate actions”. They have an important bearing, similar to financial results. With the information revolution, most people are well-versed with financial results. However, the discovery of a ‘surprise element’ of corporate actions/events act as a big trigger in the upward or downward movement of stock prices. A good example of the discovery process in recent times is the demerger of its cement division by Grasim, which caused a downward movement in its prices.
Corporate actions provide an option to enter, exit or hold the stock. Many a time, we see that a stock is stagnant at a particular level or range. However, on announcement of a corporate action/event, there is an upward movement in prices. Sometimes, it may be speculative in nature, too. Such speculative movements can be used for the purpose of exit at the right price and then re-entering the stock at a lower level. The same strategy can be used vice versa. As an investor, it is important to know the tax implications of different corporate actions, so as to know the ‘effective returns’ of your investment decision.
Let’s look at some corporate actions that companies effect:
Dividend
This is a payment made to shareholders of the company from its profits. The dividend announced is a percentage of the face value of the company’s share or on a per share basis. On the record date, (the date which the company announces to determine the shareholders who are eligible for the dividend), the shares should be in your name.
The best part is that dividends are tax-free in the hands of shareholders. Some companies declare a dividend before the financial year’s closure. These are known as Interim Dividend. Stock prices jump up on announcement of liberal dividends. Hindustan Unilever, Colgate Palmolive, TCS are very liberal in their dividend payouts.
Bonus
Companies with high ‘reserves and surplus’ may reward its shareholders with free shares known as bonus shares. A bonus ratio of 1:3 means a shareholder will get one share for every three held by him. Reliance has recently announced a 1:1 bonus issue for its shareholders. Due to the issuance of bonus shares, the company’s equity capital increases, as do the number of shares.
Usually, a handout of bonus shares is indicative of the superior prospects of a company. It also shows the confidence of the management in servicing of a larger equity base in the coming years. Normally, a bonus announcement causes a rise in the price of the shares. For tax purposes, the cost of the bonus shares is taken as nil.
Rights issue
It means offering additional shares to the existing shareholders of the stock. The rights issue may be to raise capital for business expansion, acquisition of companies or to meet capital expenditure. Existing shareholders are provided the ‘right’ to buy the stock at discounted rates as compared to the current price, making it lucrative. However, at times we see on announcement of a rights issue that the market price of shares may drop below the rights issue price. However, a decision should be taken from a long-term point of view.
For tax purposes, the cost of the rights shares will be considered for the purpose of computing capital gains on sale of such shares. A more recent phenomenon is QIP (Qualified Institutional Placement), wherein the shares of the company are privately placed with institutional shareholders such as foreign institutional investors, domestic institutions, insurance companies, mutual funds, etc.
Buyback offers
If a company wants to delist its shares or the company has surplus cash or the promoters want to increase their stake or in case they offer to buy back the shares from the shareholders. The offer is usually at a premium to the existing market price, to make it attractive to the shareholders. The announcement of a buyback of shares cause the share prices to shoot up temporarily. Buyback can be through the open market i.e. through purchase of shares on a stock exchange or by way of offer to existing shareholders.
In case of open offer, if a company plans to buy only 20 per cent of the equity, and the total shares tendered are more than 20 per cent, then the company will buyback the shares proportionately. When an investor offers his shares in such a transaction, this is not routed through a stock exchange and no securities transaction tax is paid on it. Therefore, the investor is not eligible for the exemption from capital gains available to equity investors who sell shares through a stock exchange.
Stock split
At times, a company decides to split its shares to boost liquidity of the stock. Although more shares would be available in the market to either buy or sell, this action does not add much value to the company's stock. A stock split also leads to dilution in a company's earnings per shares, commonly known as EPS. The reason for stock split is to make the shares more liquid and reduce the price per share. For tax purposes, the date of buying the original shares is considered the date of acquisition. The cost of shares for tax purposes will be computed in the same ratio as the split ratio. Recently, Bharti Airtel split its share from a face value of Rs 10 to Rs 5 each.
Mergers and acquisitions
Sometimes, two companies merge to gain possible synergy. Mergers are generally perceived as a positive signal. For example, Reliance Industries’ merger with Reliance Petroleum, where the ratio was 1:16, that is, for every 16 shares of Reliance Petroleum, a share of Reliance Industries was allotted. Usually, in case the merger ratio is favourable for one of the companies, it causes a spurt in the price of the company for whom the ratio is favourable.
Takeovers
A takeover means a change in ownership from the existing one to new shareholders, which can be a friendly or a hostile one. In case of takeovers, the new management may make an open offer to buy shares up to a certain percentage from existing shareholders. For instance, Ranbaxy Laboratories’ takeover by Daiichi Sankyo. Sometimes, a takeover offers a good opportunity to exit the stock during the open offer. The stock may be acquired later from the market at a lower price. The impact of taxes should be considered while doing so.